AFTER months of persistent sell-off, foreign investors in the Pakistan equity market turned net buyers on May 14. Although the net portfolio inflow was worth an unimpressive sum, many investors wondered if it was the harbinger of the return of the foreigner.

Their hope was built on an event that took place a day earlier when the New York–based MSCI Inc., a leading provider of research-based indexes and analytics, announced the results of its semi-annual review. It retained Pakistan in the Emerging Market (EM) Index, belying local investors’ fears of a downgrade to the Frontier Market (FM) Index.

But some sage veterans of the stock market asked excited investors to calm down. “One swallow does not make a summer,” they said. The mood of asset managers of international passive funds — those that invest for longer terms — will have to be watched for a couple of weeks before an informed decision can be made.

That aside, local participants breathed a sigh of relief as nothing could have been worse than a downgrade in the current uncertain economic and market scenarios. But the Pakistan capital market had nothing to show to remain in the EM Index. The benchmark KSE-100 index has slumped by 7,280 points or 18 per cent, giving out a negative return of over 20pc in dollar terms, since the last MSCI quarterly review in February this year.

Pakistan has three constituents in MSCI EM: MCB Bank with a 43.9pc share, Oil and Gas Development Company (OGDC) 28.3pc and Habib Bank Ltd (HBL) 27.8pc. The fresh review effective from June 1 will have Pakistan’s weight in the MSCI EM Index at 0.026pc — down from 0.035pc at the time of the last rebalancing on Feb 12. And it is this minuscule weight that has left a consistent frown on the faces of some old-time brokers who insist that Pakistan was better off in the MSCI FM Index with a much higher weight of 8pc.

Pakistan has managed to stay on the MSCI EM Index with all three scrips retained in the latest review

Pakistan was part of the MSCI EM Index from 1994 to 2007. But during the stock market crash of 2008, panicked regulators and stockbrokers decided to close the exit door for foreign investors. In effect, it trapped foreign portfolio investors in the country. When the dust finally settled, beleaguered foreign funds marched out of Pakistan and MSCI demoted the Pakistan MSCI Index from EM to FM. The country’s equity market thus lost its access to the trillions of dollars that EM fund managers track.

After years of cajoling and pleading with MSCI, Pakistan celebrated its return to the EM in May 2017. However, it turned out to be an unmitigated disaster. The excitement over the reclassification to the EM was built on the premise that between $300 million and $500m would flow into the Pakistan equity market from global investors on the first trading day after the upgrade. However, tables were turned on June 1 as investors watched in disbelief when at the close of the trading session the KSE-100 index succumbed to a record single-day decline of 1,811 points with a massive sell-off in place of expected inflows from foreigners.

The event triggered a bear market that saw the index sink from its all-time high of 53,200 points on May 15, 2017, to 28,764 points on Aug 5, 2019, with the market offering a negative return in 2017 and 2018 and next to nothing in 2019. Foreigners have continued to dump stocks, with the outflow amounting to $227m since January 1, which is the highest among all participants.

However, traders, brokers and investors who still expect Pakistan to be on the foreigners’ radar expressed relief on the country having managed to hang on to its place on the MSCI EM Index with all three scrips retained in the MSCI Global Standard Indexes.

As per MSCI Global Index Methodology February 2020, the minimum criteria for the EM included full market capitalisation of $1,532m while free-float market capitalisation of $766m. In the latest review, the minimum criterion for full market capitalisation has been reduced to $1,400m and free-float capitalisation to $700m.

Tahir Abbas, head of research at Arif Habib Ltd, in a pre-result report had stated that assuming the cut-off date of April 28 for the semi-annual index review, only OGDC fulfilled the total market capitalisation criterion while MCB and HBL were short by $374m and $615m, respectively. “On the basis of free-float market capitalisation, none of the three constituents met the required criterion of $766m.” Analysts thought a lenient view by MSCI might have been stirred by what they call the “index continuity rule” and the ravages caused by the pandemic.

In the latest review, Pakistan’s weight in the MSCI Small Cap Index — with 16 constituents — has been revised to 0.734pc. Meanwhile, there have been two deletions and two additions from the Small Cap Index. Nishat Mills and Sui Northern Gas Pipelines have been replaced with Mari Petroleum and Pakistan Petroleum. Other scrips of the MSCI Small Cap Index include Engro Corporation, Lucky Cement, Fauji Cement, Hub Power, United Bank, Pakistan Oilfields, Engro Fertilisers, Pakistan State Oil, Bank Alfalah, The Searle Company, Millat Tractors, National Bank, Indus Motor and Packages Ltd.

Published in Dawn, The Business and Finance Weekly, May 18th , 2020